Federal Reserve raises interest rate by 0.25%

The US central bank has raised short-term interest rates for the third time since the financial crisis, stepping up the pace of tightening as policymakers grow increasingly confident that America’s enduring recovery will lift inflation.

The Federal Reserve raised the target range for the federal funds rate to 0.75 per cent to 1 per cent, in a move that has come earlier than markets were expecting as recently as last month.

Fed policymakers stuck with previous median projections that there will be a total of three increases in rates this year, defying predictions from some analysts that it would release a more aggressive set of rate-raising forecasts. One rate-setter – Neel Kashkari of the Minneapolis Fed – dissented from the vote for a rise, arguing in favour of unchanged rates.

In new language, the Fed’s statement also stressed that its inflation target is symmetric, in an acknowledgment that price growth could surpass its 2 per cent target without forcing the central bank to clamp down precipitately.

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Treasury yields dived and the US dollar came under pressure immediately after the statement. The yield on the 10-year treasury note, which moves inversely to price, fell by as much as 8.9 basis points to 2.511 per cent, its biggest intraday drop in two months. The two-year yield was down 4.6 per cent at 1.330 per cent.

The dollar index, which gauges the buck against a basket of half a dozen peers, was down by 0.7 per cent, as expectations of four rate rises were dashed.

Federal funds futures pinned the probability of four or more increases at 18.9 per cent at midday on Wednesday, down from 24.5 per cent on Tuesday, according to Bloomberg data. Odds of a June rate rise also retreated to 47 per cent, down from about 60 per cent yesterday.

Turning point

Janet Yellen, the Fed chair, signalled in Chicago this month that the Federal Open Market Committee thought monetary policy has hit a turning point that would require rate rises to come more frequently than the once-a-year pace set in 2015 and 2016.

In a press conference, Ms Yellen suggested that the Fed’s economic and policy outlook had not changed substantially since December and emphasised that she was not going to rush to judgment about the impact of changes to tax and spending policy by Congress. While some analysts expect looser fiscal policy to juice the US economy next year, Ms Yellen said “we have plenty of time to see what happens”.

Among the factors that are underpinning the Feds confidence are employment and inflation data that are approaching the Fed’s targets, a reduction for the time being in perceived risks overseas, and an ebullient mood in stock markets.

In its post-meeting statement, the US central bank signalled it was getting more confident about inflation, noting that headline price growth has moved close to its 2 per cent objective, even if its favoured measure of core inflation remains lower.

Highlighting “solid” job gains, the Fed’s statement also underscored an improvement in business investment compared with previous meetings. The risks to the outlook remain “roughly balanced” it said, mirroring recent language.

However as Fed officials’ economic forecasts showed, the Fed has by no means ditched its cautious approach to monetary normalisation, with its post-meeting statement reiterating guidance that further rate increases will be gradual.

The so-called dot plot projections pointed to a quicker pace of tightening than the once-a-year speed set over the past two years, but the Fed forecasts remain shy of predictions by some forecasters that there could be four increases this year.

– Copyright The Financial Times Limited 2017